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Market-Implemented Monetary Policy with Open Mouth Operations

This paper presents a model in which investors, acting in self-interest, force interest rates to the levels desired by the monetary authority. If interest rates move out of line with those required by the monetary authority, a statement (an open mouth operation) is all that is needed to restore them. We argue the current implementation of monetary policy in New Zealand works in this way. Using announcement data from New Zealand, we find that open mouth operations lead to large changes in interest rates across all maturities, and these changes cannot be explained by open market operations. Implications are drawn for research in other areas, in particular the news approach to exchange rate modeling, the expectations theory of the term structure of interest rates and measuring the liquidity effect.